FINAL MACRO EXAM

What did Roosevelt do in 1933?

in 1933 the president created a bank holiday to check books of all the banks so they were closed. After the holiday, only healthy banks were opened. The money drop was supply plummeted from 25% to 33% the largest drop ever in the 2007-2008 crisis.

What happens when the gov't bond prices rise to interest rate?

interest rate declines

Monetary multiplier

the reciprocal of the required reserve ratio; it is the multiple by which the banking system can expand the money supply for each dollar of excess reserves.

restrictive monetary policy

tight money policy, increases interest rate to reduce borrowing and spending which will curtail (reduce in extend or quantity) expansion of aggregate demand and hold down price level increases.

What is the basis of modern banking?

to operate on primary purpose of legal reserve today

Federal Open Market Committee (FOMC)

-Aids the Board of Governors in conducting Monetary Policy -Made up of 12 individuals who are: 7 members of Board of Governors, President of New York Feds, Four of the remaining presidents of Federal Reserve Banks on a 1-year rotating basis. -directs the purchases and sale of government securities (bills, notes, bonds) in the open market which such securities are bought and sold on a daily basis. -control the nation's money supply and influence interest rates.

The monetary multiplier (expansion multiplier)

-defines the relationship between any new excess reserves in the banking system at the creation of new checkable deposit money -reciprocal of required reserve ratio - m= 1/required reserve ratio -can be used to find max amount of new checkable deposit money that can be created.

What're advantages of monetary policy?

-include its flexibility and political acceptability -in recent years Fed has used monetary policy to keep inflation low while helping limit the depth of recession of 2001, to boast the economy as it recovered from that recession to help stabilize banking sector, and to promote recovery from severe recession of 2007-2009. Today nearly all economists view monetary policy as a significant stabilization tool.

What happens when federal reserve banks buy government bonds from commercial banks?

-the commercial banks give up part of their holdings of securities to the Federal Banks -The Federal Reserve Banks, in paying for these securities place newly created reserves in the account of the Commercial Banks at the Federal Reserve of the commercial banks go up by the amount of the purchase of securities. -if you increase reserves you increase lending ability.

Restrictive Monetary Policy

1) Problem: Inflation 2) Fed sells bonds, increases reserve ratio, raises discount rate or decreases reserve ratio 3) excess reserves decrease 4) federal funds rate rises 5) money supply falls 6) interest rate rises 7) investment spending decreases 8) aggregate demand decreases 9) inflation declines

Expansionary Monetary Policy

1) Problem: Understand unemployment recession 2) Fed buys bonds, lowers reserve ratio, lowers discount rate or increases reserve auctions 3) excess reserves increase 4) federal funds rate falls 5) money supply rises 6) interest rate falls 7) investment spending increases 8) aggregate demand increases 9) real GDP rises

What are the four main tools of Monetary Policy?

1) open-market operations 2) reserve ratio 3) discount rate 4) term auction facility

What are monetary policies major limitations?

1) recognition and operation lags complicate the funds of monetary policy 2) in a severe recession the reluctance of banks to lead excess reserves and to borrow money to spend on capital goods may contribute to a liquidity trap that limits the effectiveness of an expansionary monetary policy.

How does the money multiplier work?

It works in both directions; it applies to money destruction from the payback of loans as well as the money creation from the making of loans.

Legal Tender

Meaning that specifically each bill contains the statement, "this note is legal tender for all debts, public and private." Meaning paper money is a valid and legal means of payment of any debt that was contracted in dollars. (but private firms and government are not mandated to accept cash. It is not illegal for them to specify payment in non-cash form such as checks, cashier's checks, money orders, or credit cards).

Money

Money is a social invention. Money is the only commodity that is good for nothing but to be gotten rid of. Money is what money does. Therefore, anything that performs the function of money IS money.

Unit of Account

Money is measurable, so used to determine worth of wide variety of goods, services and resources. an example would be:

What happens when the Fed wants to sell bonds?

Price decreases, and interest increases

Money Definition M1

-currency (coins and paper money) in the hands of the public. -all check-able deposits (cash and checks)

Fiscal Policy

-uses tools to stimulate economy or destimulate the economy -increases government spending -reduces taxes -or a combo of the two

What is the reserve ratio for all commercial banks?

20 percent

How long is the term of a Board of Governor?

Terms are 14 years and staggered so that one member is replaced every 2 years. Also, new members are appointed when resignations occur. The chairperson and vice-chairperson of the Board serve 4-year terms and can be reappointed to new 4-year terms by the president. The long-term appointments provide the Board with continuity, experienced membership, and independence from political pressures that could result in inflation.

What are quasi-public banks?

The 12 federal reserve banks are quasi-public banks, which blend private ownership and public control. Each Federal Reserve Bank is owned by the private commercial banks in its district. Board of Governors sets the basic policies that the Federal Reserve Banks pursue. In practice they're public institutions. Not motivated by profit. The activities by Federal Reserve Banks are frequently at odds with the profit motive, and don't compete with commercial banks. They don't deal with the public, rather they interact with the government and commercial banks and thrifts.

Who controls money supply?

The Federal Reserve. This unique about the situation is that the Federal Reserve is independent of the gov't so cannot be directed.

How do board of governors get appointed?

The U.S president, along with confirmation from the Senate, appoints 7 Board members. The president chooses the chair-person and vice-chairperson of the Board from among the members.

Term Auction Facility

The Fed holds two auctions each month when banks bid for the right to borrow reserves for 28 days and 84 day periods. Banks who want to participate submit bids that include the amount they wish to borrow and interest rate they'd be willing to pay. They're submitted secretly, lending through term auction facility guarantees amount of reserves that the Fed wishes to lend will be borrowed. The procedure for interest rate on loans serves to produce equilibrium price at which quantity demanded for loans exactly equals quantity supplied of loans // amount Fed is auctioning.

How does monetary policy affect the economy?

Through complex cause-n-effect chain -policy decisions affect commercial bank reserves -changes in reserves affect money supply -changes in money supply alter interest rate -changes in interest rate affect investment -changes in investment affect aggregate demand -changes in aggregate demand affect equilibrium, real GDP, and price level

What is the goal of monetary policy?

To help the economy achieve price stability, full employment, and economic growth.

Fiat Money

currency that government declared legal tender, is not backed by a physical commodity. undue derived from relationship of supply and demand. anything that is money because the government has decreed it to be money.

What're the three functions that money should perform to be effective?

1) medium of exchange 2) unit of account 3) store of value

How many Federal Reserve Banks are there?

12

Token money

Means that the face value of any piece of currency is unrelated to its intrinsic value- or the value of the physical material (metal, paper, ink) out of which that piece of currency is constructed.

Board of Governors

the central authority of the U.S money and banking system.

Discount Rate

-interest charged to commercial banks for borrowing from federal reserve -borrowing from federal reserve banks increases the resources of the borrowing commercial bank -creates excess reserves -enhances ability to extend credit

Targeting Federal Funds Rate

The Federal Reserve focuses on monetary policy on the interest rate that can directly influence the federal funds rate. This is the rate of interest that banks charge on another on overnight loans made from temporary excess reserves. The Federal Reserves target federal funds rate by manipulating the supply of reserves offered in federal funds market.

Liquidity

The ease with which it can be converted quickly into the most widely accepted and easily spent form of money, cash with little or no loss of purchasing power. More liquid an asset, more quickly it can be converted to cash. Cash is perfectly liquid, a house is highly illiquid.

Bankers' Bank

The Federal Reserve Banks are "bankers' bank". They perform essentially the same functions for banks and thrifts as those institutions perform for the public. Just as banks and thrifts accept the deposits of and make loans to the public, so the central banks accept the deposits of and make loans to banks and thrifts.

What are excess reserves?

The amount by which a bank's or thrift's actual reserves exceed its required reserves; actual reserves - required reserves.

Expansionary Monetary policy

this will lower interest rate to bolster borrowing and spending to increase aggregate demand and expand real output.

What do we mean by reserve ratio?

The specified percentage of check able-deposit liabilities that a commercial bank must keep as reserves. It must keep to the bank's own outstanding checkable-deposit liabilities.

What function does the Federal Reserve Banks have that banks and thrifts and banks do not?

They issue currency. Authorized by the Congress the Federal Reserve Banks to circulate Federal Reserve Notes which constitute the economy's paper money supply.

Medium of exchange

Usable for buying and selling goods and services. Also is readily acceptable as payment (AKA no bartering). an example would be:

Bond Markets

Bond markets are open to all buyers/sellers of corporate and government bonds (securities). Federal reserve is the largest single holder of the U.S government securities.

When Fed sells government bonds to commercial banks..

-Federal Banks give up securities that the commercial banks acquire -Commercial banks pay for securities by drawing checks against their deposits or reserves in Federal Reserve Banks. The Fed collects on those checks by reducing commercial banks reserves accordingly.

Federal Funds Rate

-the interest rate that banks charge one another for overnight loans of reserves -the interest is the benchmark rate that banks use as a reference rate for a wide range of interest rates on short term loans to businesses or individuals.

What happens when there is a change in reserve ratio?

Affects money-creating ability of banking systems by: 1) change amount of excess reserves 2) changes size of monetary multiplier

What does the term auction facility allows what?

Allows the Fed to alter the money supply by increasing or decreasing the amount of reserves it auctions off every 2 weeks.

What happens when the Fed buys government bonds?

An increase in demand

What is the Federal Reserve Banks made up of?

Blends private and public control, also serves a bankers' bank. (commercial banks, thrift institutions aka savings and loan associations, mutual savings banks, credit unions)

What does quasi-public mean?

Blends private ownership and public control.

Explain a single bank in a multibank system?

Can safely lend (create money) by an amount equal to its excess reserves; the banking system can or create money by a multiple of its excess reserves

Who do the Federal Reserve Banks not compete against?

Commercial Banks, they normally don't deal with the public. Instead they interact with the government and commercial banks and thrifts.

Open-Market Operations

Consists of buying government bonds from or selling government bonds to commercial banks and the general public. the conduit for OMO is the NY Federal Reserve Bank and 16 financial firms called primary dealers. These buy bonds only to sell to banks and public. OMO are Feds most important day-to-day influencer of money supply.

When was the federal reserve created?

Created in 1913 after the bank crisis in 1907

What happened in the 2007-2008 crisis?

FDIC increased deposit insurance from 100,000 to 250,000 per account and the federal government guaranteed the safety of all balances in money market mutual fund accounts.

Reserve Ratio

Feds can manipulate this to influence banks ability to lend. Raising can increase the amount of required reserves the bank must keep. So, banks can either lose excess reserves by diminishing ability to create money by lending or to find reserves deficient and forced to contract checkable deposits AKA money supply. Lowering the R.R makes required reserves into excess reserves and enhances the ability of banks to create new money by lending.

What are modern banking systems

Fractional reserve systems: only a fraction of checkable deposits is backed currency.

How are bond prices and interest rates related?

INVERSELY

Store of Value

Money enables people to transfer purchasing power from the present to the future. an example would be:

Money Definition M2

Near monies- certain highly liquid financial assets that do not function directly or fully as a medium of exchange but can be readily converted into currency or checkable deposits. Includes 3 categories: -savings deposits, including money market deposit accounts -small-denominated (less than $100,000) time deposits -money market mutual funds held by individuals

Discount Rate

When a commercial bank borrows it gives Federal Reserve Bank an IOU against itself and with collateral of U.S. gov't securities. The Fed. Reserve bank charges interest on loans they grant to commercial banks. They discount rate is the interest rate they charge. -borrowing from federal reserve banks by commercial banks increases the rev. of commercial banks and enhances their ability to extend credit. Increase in discount rate discourages banks from obtaining additional reserves.

The Taylor Rule

assumes that the Fed has a 2% target rate of inflation, that is willing to tolerate and that the FOMC follows 3 rule settings its target for fed -when real GDP equals potential GDP and inflation is at its target rate of 2%, Federal funds target rate should be 4% implying real Federal Funds rate of 2% -for each 1% increase of real GDP above potential GDP, Fed should raise real Federal funds rate by 1/2% point. -For each 1 % increase in inflation rate above its 2% target rate the Fed should raise the real federal funds by the 1/2% point.

What is the basic function of the Federal Reserve Bank?

collectively serves as the nation's central bank, whose policies are coordinated by the Fed's Board of Governors. The 12 banks accommodate the geographic size and economic diversity of the U.S and the nation's large number of commercial banks and thrifts.

What happens when Fed sells securities in open market?

commercial bank reserves are reduced, and produces a decline in nations money supply.

Reserve ratio formula

commercial bank's required reserves/ commercial bank's checkable-deposit liabilities.